The launch of the first-ever Bitcoin exchange-traded fund (ETF) in the United States has grabbed headlines and is a testament to the increasingly mainstream nature of crypto from a legal and regulatory perspective. While this is certainly great news for the sector and should be recognized for the legitimization it brings, it also has the potential to help solve another lingering problem for advocates of the cryptography; crypto accounting.
Accounting may not always make the hottest or most exciting headlines, but it is absolutely essential for individuals and institutions looking to fully integrate crypto into day-to-day transactions. The lack of crypto-specific accounting and reporting rules is not only a barrier to wider use of crypto, but also fails to reflect the economic reality related to crypto-assets. The launch of tradable and investable bitcoin and crypto products that virtually anyone can invest in is a dramatic step in the right direction, but the current accounting treatment will remain a significant headwind for now.
Let’s take a look at the current treatment, the issues it raises, and the other options that – indirectly – the launch of a bitcoin ETF opens up to the market.
The problem. The current consensus on how to account for and report crypto-assets is to treat them as if they were the equivalent of indefinite-lived intangible assets. At first glance, this looks like a perfectly reasonable approach; Crypto-assets are intangible in nature, and even the tokenization of physical assets still results in the creation of intangible tokens. Where the problem arises, however, is that by classifying and treating crypto as such, it means that these assets must also be tested for impairment on a recurring basis.
Without delving into too much accounting detail, impairment testing is a multi-step process that should be performed either 1) on an annual basis, and/or 2) when a change in economic conditions necessitates more frequent testing. Given the volatility of bitcoin and other crypto-assets – which have recently trended upwards but have not always been linear – this could force organizations to depreciate different crypto holdings. These losses, even if no external transactions take place at these lower price levels, will appear on both the balance sheet and income statement of these organizations.
The real problem, however, is that these losses are permanent and can never be reversed, even if the prices of these assets subsequently recover. In other words, the reality of asset valuations may not appear in financial statements prepared in accordance with generally accepted accounting principles (GAAP). As organizations across different economic sectors transact bitcoin, hold some of it as a reserve on their balance sheets, or hold it on behalf of customers, it is quickly becoming a mainstream consideration in the market.
A potential solution. Launching a bitcoin ETF might not seem, at first glance, a potential solution to the above-raised issues regarding accounting, depreciation and reporting of crypto-assets. However, a closer look reveals several key elements that market players should notice and incorporate in the future.
First, the launch of a bitcoin ETF signals the approval of this idea – obviously enough – by the Securities and Exchange Commission (SEC). Aside from the ongoing talk of whether cryptos are securities at the moment, there is another angle to this story. Simply put, the fact that in addition to the Internal Revenue Service (IRS), the SEC is actively engaging with the industry opens the door for a re-examination of crypto accounting issues, as policymakers are clearly interested in – and better understand – space.
Second, and building on this increased acceptance and understanding, market players have the opportunity to attempt to shift the conversation around regulation. As more and more organizations buy, sell, hold, and otherwise use crypto as a core part of their operations, it makes sense that regulatory — and hopefully accounting — conversations evolve and mature.
It is too early to say with any authority how the conversation around crypto accounting will evolve, as depending on the specific crypto-asset in question, the accounting treatment could logically vary widely. Treating and classifying crypto as derivatives, commodities, cash equivalents, or stocks may make sense depending on the facts and circumstances of the situation. In this context and the complications that come with such a diverse industry and space, it would be foolhardy to attempt to address all accounting and reporting issues simultaneously.
One place to start this process, however, is to incorporate crypto-assets into existing accounting and reporting frameworks and allow organizations to hold these financial instruments at fair market value (current market price). Volatility will never disappear from the crypto industry, or any other space, but allowing these changes to display in a transparent, comparable, and consistent manner is essential. The purpose of accounting and reporting rules, after all, is to communicate information and data relating to the performance of the organization or asset, and it is time for crypto accounting to catch up with market realities.